“Present value” is the cost today to fund an amount to be paid in the future. That amount is called the “future value.” Any time damages will be incurred in the future, an issue arises about how to value those damages. For example, if the plaintiff cannot return to prior employment, future lost earnings must be calculated. Typically, loss of earnings is projected from the present to normal retirement age. There may also be a calculation of lost retirement benefits due to plaintiff’s inability to accrue further retirement benefits. Ongoing medical expense may be the most common element of future damage.
Thing is, a dollar to be paid in the future doesn’t cost a dollar today. Money can be invested to earn interest over the years, so the future benefit can be funded today with a smaller amount, the present value. Two kinds of professionals can help calculate the present value of a future benefit: economists and structured settlement brokers.
Forensic Economists
Forensic economists specialize in testifying about issues such as inflation rates, investment returns, and other factors impacting present value. Once the court accepts the economist as an expert, the economist can provide an opinion of how much money is required today to fund a stream of payments over a period of time or a single payment in the future. If your case is large enough to warrant the cost of retaining an expert economist, the defense will almost certainly retain one as well. The defense economist will probably testify that the plaintiff’s economist is using incorrect assumptions or methodology, and the value of the disputed future benefit stream is much less. Likewise, the plaintiff’s economist will say the defense’s assumptions are wrong. Who’s right? Or is the answer somewhere in between? That’s what juries decide.
Structured Settlement Brokers
Another choice is to get present value calculation from structured settlement companies or brokers. Structured settlement brokers sell structured settlement annuities, a special kind of settlement tool used to make investment income earned on settlement proceeds tax-free. Personal injury settlements received at time of settlement are tax-free, but not the investment income later earned on those proceeds. Structured settlement payments comprised of principal and investment income are made over time to the plaintiff according to a schedule of the plaintiff’s choosing.
The broker gathers data about the plaintiff‘s age, gender, and life expectancy and about the amount and timing of the payments. This information is input into software programs provided by major U.S. life insurance companies who issue structured settlement annuities. The programs’ algorithms are based on the life company’s underwriters’ opinions and projections about future interest rates. The result is the cost, or present value, of how much it costs to purchase an annuity which will provide the desired benefit. Just as with the economist, the structured settlement broker can adjust the start date, end date (including lifetime annuities) and even an assumed inflation factor.
Structured settlement brokers do not charge for their services. They are paid a commission by the life insurance company when the annuity policy is issued. Therefore, this is an inexpensive way to obtain present value information without incurring the expense of hiring a forensic economist. If the case looks likely to settle or is too small to warrant the expense of an economist, using the broker is a smart way to obtain this information.
Structured settlement brokers can testify as expert witnesses in some states. But if the defense has retained a forensic economist, you will probably want your own for testimony. You can use the broker early in the case and retain an economist later; it’s not an either/or situation. Keep in mind that statute may require you to identify your expert witnesses before a deadline of so many days before trial so the other side has time to take the expert’s deposition.
Some economists will argue the cost of an annuity is not the same as present value. For your purposes, however, it will work. The benefit of the annuity cost calculation is that it is a real number. You can buy that benefit for the specified price. The economist, on the other hand, is giving an opinion. If the economist’s assumption about future interest rates turns out to be wrong, the present value calculation would be incorrect. However, once purchased, the annuity benefit cannot change.
Lifetime benefits
A key component of your settlement may include replacement of a lifetime benefit stream. Common examples include medical treatment and lost retirement benefits. To calculate a lifetime benefit, the economist or structured settlement broker must figure in your expected lifetime. The federal government and private organizations publish mortality tables which provide statistics on life expectancy categorized by race and gender. The tables state the average life expectancy of someone who has “normal life expectancy.” But that may not be you. Maybe the injury which is the subject of the lawsuit has diminished your life expectancy, or you may have other medical conditions which shorten life expectancy.
An economist will use the life expectancy projections in medical reports from treating and non-treating doctors. The defense’s expert doctor is likely to project a shorter life expectancy than your treating physician or your medical expert. Doing so reduces the present value of the benefit stream because there are fewer payments to be made.
A structured settlement broker will use a “rated age.” This is like the “biological age” quizzes you can find on the internet. The difference is that the rated age is used in a life expectancy calculation only to shorten the projection, never to lengthen it. Each life insurance company has an underwriting committee which will review medical records and advise the broker what age to use in calculating benefits. If a person has a condition impacting life expectancy, the present value (cost) of that lifetime benefit stream will decrease. This can be a good thing if you are dealing with a fixed sum and want to make it go farther. If you are in good health or have longevity in your heredity, you are likely to beat the odds and get a fantastic rate of return over your lifetime.
The Calculation
Present value can be calculated using a compound interest or discount rate formula. You are probably familiar with compound interest; that’s how banks pay interest on their deposits. Discount rate works in the other direction. Starting with a future value, a discount is applied for each year back to the present.
Economists and structured settlement underwriters make certain assumptions about the future of interest rates. They assume an applicable interest rate to calculate the present value. Parties often challenge those assumptions during negotiation.
Present value calculations are based on a formula:
PV stands for Present Value. FV is Future Value. “i” is the assumed annual interest rate. “n” is the number of years.
An expert could use this formula or a table. But in fact, pretty much everyone uses a computer. You can easily run your own present value calculations. Search the internet for “present value calculator.”
The biggest question is what interest rate to use. Since the recession of 2008, interest rates have been at a historic low. One might assume today that interest rates will significantly rise over the plaintiff’s lifetime. At the end of 2015 the highest yielding one-year bank certificates of deposit earned interest at an annual rate of about 1¼%. A defense expert might opine that over the next fifteen years, the average investment interest rate will be 4%. But an assumption about whether a given amount of money today will produce the amount necessary to pay for future needs may never be realized.
Even if that assumption comes to fruition, that doesn’t guarantee you will be able to earn that amount. Investment risk reduces the return most investors realize. If you earn low interest in the first years after settlement, there will be a small principal amount to invest in later years when interest rates might be higher. Therefore the average rate over an extended period may not be the appropriate measure.
The likelihood that today’s present value will be adequate years in the future is further threatened by inflation risk. Inflation decreases the buying power of your dollars. If you earn an interest rate that just equals the rate of inflation, you will need the same dollar amount today as in the future, not a smaller one. Overall inflation has been low since 2008. But the inflation rate for medical expenses has increased faster than for most other sectors of the economy.
Jury instructions
Part of the evaluation process is a consideration of what will happen if the case goes to trial. One of the jury’s jobs is to consider present value in calculating the verdict.
Any time a plaintiff presents evidence that the money to be awarded in the verdict will come due in the future, the court will instruct the jury how to calculate the present value. Here is a sample jury instruction:
To recover for future harm, Plaintiff must prove that the harm is reasonably certain to occur and must prove the amount of those future damages. The amount of damages for future harm must be reduced to present cash value. This is necessary because money received now will, through investment, grow to a larger amount in the future. Defendant must prove the amount by which future damages should be reduced to present value.
To find present cash value, you must determine the amount of money that, if reasonably invested today, will provide Plaintiff with the amount of Plaintiff’s future damages.
You may consider expert testimony in determining the present cash value of future damages. You must use any interest rate and other information agreed to by the parties in determining the present cash value of future damages.
Put yourself in the jurors’ shoes. How would this instruction change your view of the value of the case? How can you best present the different factors which could impact present value?